Home builders have painted a relatively optimistic picture this week of the trajectory of the new-home market going into the spring selling season, but mild concerns linger about whether those results truly mirror the broader market.
Five large, publicly traded builders have reported quarterly results so far this week, with most posting heady gains in sales contracts for their latest quarter in comparison to a year earlier. D.R. Horton Inc.’s overall sales were up 35%; MDC Holdings’ Inc. by 18%, Meritage Homes Corp.’s by 12% and Ryland Group Inc.’s by 8.3%. PulteGroup Inc. was the laggard with a 1% gain.
What’s more, many in that group said that sales momentum that began in November and December has carried through to January. That bodes well for the spring selling season, which begins after the Super Bowl and typically hits its stride in March and April. “January has continued to be quite positive,” Pulte Group Chief Executive Richard Dugas said during the builder’s call with investors on Thursday.
That optimism took hold of investors, too, on Thursday, pushing up the Dow Jones U.S. Home Construction index of six large home builders’ stocks by 4.3% for the day. The builders’ perspectives on recent market momentum seem to support projections by several economists that 2015 will bring double-digit percentage gains in new home sales after a gain of just 1.4% last year.
“Fourth quarter results and guidance were incrementally constructive,” said Robert Wetenhall, an analyst tracking home builders at RBC Capital Markets. “However, it remains to be seen how the spring selling season will unfold.”
Yet some analysts are leery, noting much of the builders’ sales gains in recent quarters, including the latest, have come as a result of outward expansion rather than more preferable internal growth. In other words, builders are reaping more of their gains these days by starting construction of entirely new projects, called “communities,” rather than by selling more homes in their existing communities. The latter often is called per-community sales, or absorption.
Why the concern? It’s possible that sales gained from opening new communities represent more a siphoning of sales from other builders than they do an increase in overall demand for new homes.
It’s similar to the retail industry’s focus on same-store sales, which tracks changes in sales volumes only at stores open for at least a year. That reveals how much in incremental sales a retailer is wringing from its existing network of stores, which have relatively fixed costs. In contrast, brand-new stores often generate a portion of their sales by siphoning sales from older stores, both from rivals and from within their own chain.
Why does it matter? Sales growth from opening new communities sometimes isn’t as profitable for builders as generating more sales in existing communities, because the new communities have much greater marketing and sales costs. But, more importantly, it can be argued that sales from opening new communities isn’t as clear a gauge of new-home demand as are sales from existing communities.
“If you believe that demand is relatively flat (nationally), then they’re cannibalizing each other’s sales” by opening large numbers of new communities, said David Goldberg, an analyst with UBS Securities.
The difference between these two types of sales is substantial for some builders. While D.R. Horton’s overall number of sales contracts was up 35% in its fiscal quarter ended Dec. 31, its per-community sales were up only 6% from a year earlier. Meritage posted a 12% gain in overall sales last quarter, but its per-community sales declined by 9%. Ryland gained 8% in overall sales, but its per-community sales declined by 8%.
“I don’t think anybody, us included, is happy with absorption rates today,” Ryland CEO Larry Nicholson said Thursday on a call with investors, using the alternate term for per-community sales.
In research notes distributed this week to his firm’s clients, Wells Fargo Securities analyst Adam Rudiger has pointed to builders’ weak results in per-community sales in describing overall new-home demand as “lackluster” and “stuck in low-growth mode.”